What is Bitcoin? IRS says it knows

The U.S. government will treat Bitcoin as property for tax purposes, applying rules it uses to govern stocks and barter transactions, the Internal Revenue Service said in its first substantive ruling on the issue.

Today’s IRS guidance will provide certainty for Bitcoin investors, along with income-tax liability that wasn’t specified before. Purchasing a $2 cup of coffee with Bitcoins bought for $1 would trigger $1 in capital gains for the coffee drinker and $2 of gross income for the coffee shop.

The IRS, faced with a choice of treating Bitcoins like currency or property, chose property. That decision could reduce the volume of transactions conducted with the virtual currency, said Pamir Gelenbe, a venture partner at Hummingbird Ventures, which invests in technology businesses.

“It’s challenging if you have to think about capital gains before you buy a cup of coffee,” he said.

Charles Allen, chief executive officer of BitcoinShop Inc., an online marketplace, said he’d like to see the IRS reconsider its decision as virtual currencies develop.

“The implications this decision will have on the Bitcoin ecosystem are far reaching, and will be burdensome for both individual users of Bitcoins, Bitcoin-focused business and for the general adoption of virtual currencies,” he said, adding that Bitcoin users will adapt to the rules.

Technological Breakthrough

Bitcoin, the most popular digital currency, emerged from a 2008 paper written by a programmer or group of programmers under the name Satoshi Nakamoto. The Bitcoin network uses a public ledger to record transactions made under pseudonyms, a technological breakthrough that allows purchases and sales without using a trusted third party, such as Visa Inc. or Western Union Co.

Powerful computers that record the transactions and guard against double-spending the same currency generate new Bitcoins, a process referred to as mining. Mining has made some early Bitcoin adopters wealthy in dollar terms.

Others bought into the currency in early 2013, before its price rose more than 50-fold to peak at $1,200 in early December. A Bitcoin was worth $584.35 at 4:02 p.m., New York time, according to the CoinDesk Bitcoin Price Index. That’s less than 0.3 percent below today’s high.